Related party transactions always follow the presumption of not being at arm’s length and therefore tax provisions prescribe that the transactions should be undertaken at market value and be based on usual commercial terms, as if done with a third party. Transactions with related parties are always subject to scrutiny and are required to demonstrate that the transactions are driven by commercial understanding. The GST regime also prescribes for definition of related persons and applicability of valuation rules, as prescribed in case of transactions with related persons. The article intends to highlight some of the issues that the GST switch over will bring about in case of guarantee provided by related parties.
Section 15 of the Central GST Act states that the value of supply of goods or services shall be considered to be the actual price paid or payable for the purpose of taxation, where the transactions is not between related persons and price is the sole consideration for supply. In case the supply of goods or services is between related persons then the value of such supplies shall be determined by the valuation rules prescribed in this regard.
Who are related persons?
Explanation to Section 15 of the Central GST Act explains that
- persons shall be deemed to be “related persons” if
- such persons are officers or directors of one another’s businesses;
- such persons are legally recognised partners in business;
- such persons are employer and employee;
- any person directly or indirectly owns, controls or holds twenty-five per cent. or more of the outstanding voting stock or shares of both of them;
- one of them directly or indirectly controls the other;
- both of them are directly or indirectly controlled by a third person;
- together they directly or indirectly control a third person; or
- they are members of the same family;
- the term “person” also includes legal persons;
- persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related.
Therefore holding and subsidiary, associates, fellow subsidiaries shall be taken to be related persons.
Identifying issues in guarantee transactions
Rule 2 of the Determination of Value of Supply Rules, provides for determining the value of supply of goods and/ or services between distinct or related persons, other than through agent. The rule prescribes that the value of the supply between related persons shall be:
- the open market value of such supply;
- where open market value of such supply is not available, it shall be the value of supply of like kind and quality;
- and where the value cannot be determined by the mechanisms stated in (a) and (b) above, it shall be determined by application of Rule 4 or Rule 5 of the aforesaid rules.
Guarantees provided by holding to a subsidiary or transactions alike between related persons will be considered to be a supply of service for the purpose of GST and usually, there is no guarantee commission charged.
So in case of guarantees provided by related person, the valuation rules shall apply. Also there is no market for guarantee commissions or service of like nature.
Proviso to Rule 2 states that –
Provided that where goods are intended for further supply as such by the recipient, the value shall, at the option of the supplier, be an amount equivalent to ninety percent of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person:
Provided further that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of goods or services:
The provisos creates a carve out, a) where there is regular supply of such goods or b) where the recipient is eligible for full input tax credit, the value of the supply shall be based on the invoice value for the purpose of taxability.
In case of guarantee the relevant proviso is where the recipient is a full input tax credit eligible entity. In case it is not, then one will have to look at Rule 4 and Rule 5 to conclude on the value of supply.
Rule 4 and Rule 5
Rule 4 states that –
Where the value of a supply of goods or services or both is not determinable by any of the preceding rules, the value shall be one hundred and ten percent of the cost of production or manufacture or cost of acquisition of such goods or cost of provision of such services.
In case of guarantees there cannot be a computation of costs. Therefore the rule is not relevant.
Rule 5 is the residual method of valuation and states that –
Where the value of supply of goods or services or both cannot be determined under rules 1 to 4, the same shall be determined using reasonable means consistent with the principles and general provisions of section 15 and these rules:
Rule 5 exposes the determination of value of supply to the discretion of the tax officer. The officer can apply any methodology to arrive at the value of guarantee for the purpose of tax.
The definition of related persons and the rationale for valuation is in lines with the World Trade Organisation Customs Valuation Agreement.
Guarantees, as we understand will always be provided by related persons. To determine a reasonable interpretation here seems a risky proposition in itself! This will lead to varying or disregarding arrangements and value of supply determined by the contracting parties and will open up tax assessments, which may be an unwarranted exercise.
Under the service tax regime as well, there are valuation rules that could be triggered to disregard the value of the service computed by the assesse, however in case the consideration for a service was zero, then the valuation rules were not triggered to assess a deemed value and therefore no service tax was charged on zero consideration. Under the GST regime, however, there is no question of treating the value of the service as zero and drawing upon valuation rules, therefore it increases the cost of providing guarantee, dissuading companies from giving guarantees.
In case of NBFCs, where there is a service tax levied on the guarantee provided, the loss of input credit is an additional cost to the transaction.
Therefore providing of guarantee as services to related persons seems like stepping into a land mine!
Also if there are transactions in different states, the interpretation could be subject to vagaries of different tax officers.
The transition into GST is a mega reform in the Indian tax regime and for the corporates to deep dive into the ocean to find the pearls or may be feckless pennies.
by Nidhi Bothra (firstname.lastname@example.org)